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Boys at top need to realise saving Greece vital to eurozone survival

SO, Xi Jinping made it to the top in China. I liked the newspaper (which shall be nameless) which said that he had strong support. You bet he did.

But this column does not bother itself with simple matters like the Chinese way of selecting leaders. It prefers something more complicated and obscure, like the European way of dealing with its crisis.

They have one thing in common, besides being impenetrable. There is much speculation about whether Communist Party rule in China will survive the ten-year term of the new leadership. There is at least as much in Europe as to whether the euro will see its 20th birthday in 2019.

One has to say that the events of the last few weeks seem to have made that happy birthday less likely. Or perhaps not. The fog of unknowing as to what European leaders are doing – still more as to what they think they are doing – means it is possible to take either the optimistic or pessimistic view of recent developments.

The markets appear sanguine, especially when it comes to Ireland. Borrowing costs are at demanding, but no longer impossible, levels. Fitch has removed the threat of another ratings downgrade: Moody's has removed the default warning on Irish debt.

These are tiny steps, but they are not to be sneezed at. One of the most important things, half way through a cycle which seems likely to last for at least a decade, is that people begin to think things can get better. If that were followed by them actually getting better, the vicious cycle could become virtuous.

Whether it does will depend, not so much on what happens here, as what happens in Greece. It came as a nasty shock that an unimportant economy could de-stabilise the €10 trillion eurozone, but it seems ever more likely that saving Greece is essential to saving the euro.

The puzzle is whether this is recognised enough where it matters – at the top – and, if it is, whether they are prepared to do what is necessary.

When the managing director of the IMF (Christine Lagarde) rolls her eyes in disbelief at the words of the head of the Eurogroup of finance ministers (Jean Claude Juncker), you have to wonder if there is any game plan at all.

Yet there is a draft plan, and it has much to recommend it. Greece would receive help on three fronts, as well as getting the money it needs to keep going. The interest rate on that money would be cut again – to as little as half a per cent over the cost to the European rescue funds.

The timetable for repayment would be extended – perhaps to 50 years – so that the country did not have to borrow on the markets to replay debt due to the rescue funds.

Most importantly – but also most difficult – the debt burden would be reduced again, and by a larger amount. There was even a suggested mechanism: Greece would repay the loans bought by the ECB at distressed prices but the resulting ECB profits would be re-cycled to Athens via the eurozone national central banks.

There is more austerity to come since, as with Ireland, even debt relief does not stabilise the public finances, but if some of the recycled resources were channelled into public investment it might begin to turn even the Greek death spiral, which has seen output fall sharply for five years, with more to come in 2013.

Just like the Chinese, any change in policy has to have theoretical underpinning. Cue the somewhat obscure, but surely significant, words of Olli Rehn, the economic affairs commissioner. He said the commission was not hung up on the purely financial target of percentages of GDP, but would look more at the underlying "structural" position.

This is just what almost every economist has been urging them to do for the past few years. It would allow countries to ignore reductions in growth caused by austerity and concentrate on fixing the basic problems, instead of adding more austerity to chase a moving target.

Greece shows that the losses from austerity were greater than expected. The famous IMF analysis merely tries to quantify what was already observed. Despite what almost everyone says, it did not cover Ireland, but we already have four years' observation, and some studies from the ESRI and Central Bank.

These suggest that in Ireland's case, the austerity hit is about what was originally expected – for a 1pc of GDP correction, GDP falls by half a per cent.

The target does move, but you can catch it, all other things being equal. If one has an EU recession, a debt burden of more than 100pc of GDP and bank rescue repayments (for Anglo) of 1.5pc of GDP, things are anything but equal.

To deal with these, the target has to switch from the purely financial 3pc of GDP to the primary and structural deficits, i.e. before interest payments and making allowances for the weak external economy.

These are two austerity budgets short of a balance in both Ireland and Greece. To change an increasingly negative political climate, the EU will have to demonstrate that a country which does achieve these primary goals can have its debt re-structured to make the public finances sustainable.

The promise to do so has already been made – and not just at last June's summit. All the bailout countries have received it. It appears in this month's medium-term review from the Department of Finance.

Yet the structural goals of which Mr Rehn spoke are not Irish strategy, or not so you'd notice. The Government stresses the financial deficits as a proportion of GDP, while seeking early relief on the Anglo debt – which would make the Budgets a bit easier but does not address the fundamental imbalances.

The alternative, set out in some detail in the Congress of Trade Unions' pre-Budget submission, but widely espoused, is less austerity and more borrowing, on and off balance sheet, to fund public investment.

That too would make life easier, although the plans are a little vague on the degree of austerity which would have to continue alongside such stimulus. It would seem to make more sense – and perhaps be more effective – if the stimulus came once the remaining €5bn or so in the structural deficit had been closed.

None of it makes sense, though, unless that eurozone promise to assist with sustainability is honoured.

The proof will be in the final Greek package. It is too late for Greece to leave the eurozone, so the eurozone must live with Greece. Otherwise, my money is on Mr Xi.

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